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Downton Abbey Season 4: The Tax Season

(Warning: depending on how far you are in Downton Abbey, there may be no, minor, or major spoilers ahead.)

Like apparently pretty much all British drama, Downton Abbey’s central, motivating issue is inheritance. As the series begins, Lord Grantham’s cousin and the cousin’s son have died on the Titanic. Lord Grantham has no sons, and doesn’t want to break the entail on the estate, so he cannot leave his estate or his money to his daughters. Instead, Matthew, a distant cousin, becomes the heir.

By the third season, Matthew and Mary, on of Lord Grantham’s daughters, marry, and the family’s future is saved. Except that, in the Christmas special, just after Mary gives birth to a son, George, Matthew is killed in a car accident.

Season 4: The Tax Season

The first episode of Season 4 aired on Sunday, and it’s clearly going to be a good season. Why? Because we’ve moved from a focus on inheritance to a focus on tax. Yes, one of Season 4’s central plot points looks to be a tax issue.

Specifically, death duties.

We discover that Matthew didn’t have a formal will. Without such a will, apparently the estate would pass to George.[fn1] Before Matthew took his trip to Scotland, though, he drafted a letter to Mary. In that letter, he tells Mary that he intends to write a will when he returns from Scotland, and he intends for her to be his sole heir. Although the letter was not a will, he had it witnessed by two clients and, with its testamentary intent, the family’s attorney says it will function as a will.

How sensible, right? Maybe not. At dinner, after the letter/will is read, Lord Grantham says:

“I’m not sure how sensible it is. If the letter is valid, the estate will have to pay death duties twice before it reaches little George.”

Later, as Mary’s brother-in-law Thomas Branson shows her around the estate, he brings up the death duties:

Tom: “There is one subject we ought to discuss. I know your position isn’t settled, but we should.”

Mary: “Go on.”

Tom: “The death duties. If you are the heir, it won’t change them. There’s no special treatment for widows.”

Mary: “You do not surprise me”

Tom: “Seems odd really, that you have to pay just as much tax as if he’d left it to Mrs. Tiggywinkle down the road. That’s how it works.”

Mary: “So what are we to do?”

Tom: “Your father believes we should sell land and pay it off in one lump.”

So what are these death duties? And how can they possibly motivate an entire season?

Death Duties

Today, the UK tax on estates is called the “Inheritance Tax,”[fn2] while in the U.S. it’s called the “estate tax.” At the time in Britain, though, it was called the “Estate Duty.” Essentially, this death duty is a tax on the estate of a person after he or she dies. When you die, your executor appraises the value of your estate, and pays the taxes due, if any.

So what would the death duties on Downton Abbey have been? It depends on the value of the estate. Movoto estimates that it would have been worth $34.7 million in 1920 (which is roughly the right time period). If, in 1920, one pound were worth about $3.50, the estate would have been worth nearly £10 million. At that value, the estate would have been subject to a marginal tax rate of 40%. Matthew’s estate would have owed taxes of nearly £4 million.

Today, both U.S. and UK estates continue to face a top marginal rate of 40%.

Exempt Amount

So is that it? Is the government going to take almost 40% of anything I own when I die?

No. Both the U.S. and the UK exempt a certain amount from the estate tax. In 2014 the U.S. estate tax excludes $5.34 million. That is, the estate tax pretends that the first $5.25 million of a decedent‘s estate doesn’t exist. Similarly, the UK exempts an estate’s first £325,000.[fn3]

£325,000 would put a (minor) dent in Mary’s tax bill; while the tax bill would still be significant, the nil rate band would have saved the Matthew’s estate £130,000 in taxes. But that’s the 2013-2014 nil rate band. What was it in 1920?

£100. Meaning the nil rate band reduced the £4 million tax by £40.

Spousal Exemption

All that said, in the U.S., even if Downton were worth $34 million (or $400 million in 2014), there would be no estate tax due. Why? Because the U.S. has an unlimited exemption for transfers to spouses. Because Matthew and Mary were married when he died, then, if they were Americans, the unlimited spousal exemption would kick in and there would be no tax.

It functions differently in the UK. Rather than an unlimited exemption, the UK increases the exemption amount for married couples. Rather than a nil rate band of £325,000, it can be as high as £650,000. In other words, leaving it to his spouse rather than, say, Mrs. Tiggywinkle down the street would save Matthew’s estate £130,000 in 2014.

Unfortunately for Mary and her family, the UK didn’t introduce this increased threshold until October 2007. In 1920, as Tom pointed out, there was no difference between spouses.

Death Duties Twice?

Note that Matthew’s love for Mary, progressive ideals, and lack of forethought in drafting his not-quite-will imposes a significant cost on Downton. If he had left it to his son, it would have only faced one level of 40% Estate Duty. But now it goes through the tax system twice, first when he leaves it to Mary, then again when Mary leaves it to George. By failing to plan, the family may ultimately have to pay somewhere around £8 million, rather than the £4 million it would owe had the estate passed straight to George.[fn4]

Liquidity

So why does Lord Grantham want to sell of some of the land? Because of liquidity issues: just because the family has an estate worth £10 million doesn’t mean it has £4 million cash on hand to pay its tax bill. To raise that cash, then, they have to transform some of the illiquid value they have into liquid assets.

Mary and Tom have another (as of the first episode, unspecified) plans. And it looks like a significant part of season 4 will be convincing Lord Grantham that their plan will be a good idea, then pursuing that plan. And, whatever it is, I look forward to following the family’s tax compliance.[fn5]

—

[fn1] And Lord Grantham would continue to manage Downton Abbey until George reached, presumably, the age of majority.

[fn2] A slight misnomer, since, as I’ll explain shortly, it isn’t actually a tax on inheritances.

[fn3] Which, charmingly enough, it calls the “nil rate band.”

[fn4] Note that I’m actually fudging this a little bit–apparently, Mary gets half of the estate. I don’t know what happens to the other half. If it goes to George, that half will only face one level of taxation.

[fn5] This whole conundrum, as fun as I find it, is clearly Matthew’s fault. If he had actually bothered writing a will, with an attorney’s advice, he could have been aware of, and perhaps planned around, the tax issue. Which is to say: if you own a £10 million estate, you have no excuse for not having a will.

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9 thoughts on “Downton Abbey Season 4: The Tax Season”

And thus it is. Estate tax is particularly problematic for famers who tend to have lots of assets, but little liquidity (and seasonal business, to boot). Yea, it’s great to have to sell off the farm when the folks die. You know, instead of just passing it down to the next generation of farmers.

To your fn5, I say, if those with means can merely “plan around the tax issues” then the whole system is rigged. (Which it is.)

So, let’s see: I get paid for working and pay taxes on the earning. I use what’s left over to buy a house and get taxed every year for the privilege of owning a house. Then I die and the thing I bought with taxed earnings and was taxed for owning is taxed again because my survivors had the amazing benefit of paying for a funeral. Awesome system.

To your fn5, I say, if those with means can merely “plan around the tax issues” then the whole system is rigged. (Which it is.)

Not necessarily. It may be set up to encourage people to use their money in a more socially-productive way. If, for example, we (as a society) think it’s more beneficial for a person to donate their money to charity than to leave all of it to their heirs, we may take charitable deductions out of the estate tax base. And, so that it doesn’t burden people who can’t afford to get that advice, we might create a $5+ million floor on the tax.

Matthew doesn’t own the entirety of the estate: he only purchased a one-half interest. Lord Grantham’s 1/2 is still entailed to George, and Lord Grantham is still alive, so it is only Matthew’s 1/2 that they have to deal with at this stage and upon Mary’s death. I’ve no idea–and you don’t mention–what kind of tax treatment, if any, to which Lord Grantham’s 1/2 will eventually be subject. Presumably, there will be no significant tax treatment for that 1/2, or the estate could never have survived intact for hundreds of years.

Sam, you’ll probably have to go back and watch season 3, but if I remember correctly, Matthew isn’t the heir to the estate yet. Lord Grantham is still alive. He was being trained to be the heir. Then, when he came into a large amount of money as a surprise inheritance, he essentially invested in Downton to keep it afloat, and in return, Lord Grantham made him a co-owner. I have no idea what that means for the entail, but it should mean that they only owe 2 million pounds (only!) and they’ll owe the other 2 million when Lord Grantham dies.

Karen,
Okay, thanks. I was wondering why she was only half owner. So the estate has now saved 2 million pounds (for now).

Monorailred,
I’m no expert in British inheritance tax, but I think Lord Grantham’s half will face the same taxation. From what I can gather, it’s in this period that the British estate tax really ramped up and, in fact, caused significant harm to large estates. That is, the estate has stayed together so far because tax rates have been low, but I don’t think that holds going forward.

I wondered about the marital deduction in U.S. federal estate tax, since it was not unlimited back when I was taking Estate and Gift Taxation from Wally Blum. It turns out that the marital deduction was first introduced in the Revenue Act of 1948, that before then there had been some provisions that dealt with community property, but nothing more. The marital deduction beginning in 1948 was approximately 50% (my memory says that it was something like the first $100,000 and 50% of the balance), and that it became an unlimited deduction in 1981 with the first of the Reagan era tax acts. So, a Downton Abbey in the U.S. would have faced similar issues back in the 1920s.

Another issue which was completely skipped over by the writers (don’t they have any lawyers on staff over there? what’s wrong with this Fellowes fellow, anyway?) was the “opinion” Lord Grantham’s solicitor got from two “experts” that the letter Matthew left was a valid will. Before that letter would be admitted to probate in New York, the court would appoint a guardian ad litem to protect George’s interests, and you can be certain that he’d fight hard to find a way to keep the letter from being admitted to probate–there’s a 40% haircut to be saved by disallowing that “will.” And there are all sorts of interesting plot twists that could be built on that issue–especially since the court would be likely to look around for some well-connected, experienced man of property to act as the guardian ad litem–Lord Grantham! And he would obviously have an interest in protecting George’s interests, beyond the fiduciary duty he’d be assigned by the court. George is his grandson, after all.

Forget taxes,,,how could Robert make Matthew 1/2 partnership? I thought the whole purpose of the entail was to keep the estate from being split. Haven’t gone back to watch this to see how it happened. Also, Robert is fairly young, if his wife died and he remarried and had a son, that son would be the heir. Would he only inherit 1/2 of the estate? Thanks for any clarification…this is really bugging me.